The Week in Review: SEC Litigation, Sequester Countdown and AT&T

By Christopher Hammond, J.D. Candidate 2015 | Posted on

In a unanimous opinion yesterday, the Supreme Court limited the SEC’s ability to pursue civil penalties.  The Court held that the five-year statute of limitations begins to run at the moment a fraud is committed, not when regulators become aware if it.  In the case at issue, Gabelli v. SEC, the agency sued in 2008 for alleged violations occurring between 1999 and 2002.  Chief Justice Roberts noted practical difficulties in determining when a large governmental agency first discovers a fraud, concluding that Congress had not intended to permit the SEC to bring such actions so late.  Read the opinion here.  For more, see Reuters.

Two days until the sequester.  Congressional leaders are meeting at the White House this morning, but both sides appear to be bracing for $85 billion in across-the-board cuts on Friday, March 1.  While yet another short-term bill might resolve immediate funding concerns, the parties thus far remain gridlocked on tax reform proposals, which both recognize as an important bargaining chip.  House Speaker John Boehner has recently appeared more willing to tackle a comprehensive tax deal this Congress, but a solid democratic majority in the Senate is unlikely to concede to his current “no tax increases” position.  For more, see NYTimes, BBC and Politico.

AT&T has announced plans to expand into Europe with new lines of business, including wireless home-monitoring and automation.  The company will license its new Digital Life product to more than 30 companies worldwide, exceeding anticipated demand.  The move shows that AT&T, the U.S.’s largest phone provider, is transitioning to become a more general technology company, as consumers are increasingly seeking around-the-clock wireless connectivity and product integration.  For more, see Bloomberg.

From the Bench: Dichter-Mad Family Partners v. United States

By Will Schildknecht, J.D. Candidate 2015 | Posted on

The Ninth Circuit recently affirmed a judgment – from the Central District of California – that the victims of Bernard Madoff’s Ponzi scheme lack subject matter jurisdiction to sue the Securities and Exchange Commission as an agency of the United States under the Federal Tort Claims Act.

The SEC compiled a 450-page public report highlighting its failure to uncover Madoff’s problematic investment activities.  The allegations posed by the victim plaintiffs centered on decisions made by the SEC which the district court acknowledged “should have and could have been made differently” and “reveal[ed] the SEC’s sheer incompetence.”  Nevertheless, the court held that the United States was protected from suit because the Securities and Exchange Commission was engaged in a discretionary function.  An exception is set aside in the Federal Tort Claims Act (“FTCA”) whereby employees of the Government cannot be held liable for failures relating to purely “discretionary” functions of that employee.

The district court, considering the legislative history of the FTCA, noted that Congress “repeatedly and explicitly suggested” that the SEC should be shielded by the discretionary function exception.  The FTCA only allows a claim where statutory language mandates a particular course of action.  By contrast, the duties and functions of the SEC allow it discretion in choosing who to investigate and when to bring enforcement proceedings.  Because the plaintiffs could not demonstrate that the SEC violated a specific and mandatory policy directive that related to the investigation, the court held they failed to overcome an FTCA claim’s threshold requirement.

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Crown Jewels — Restoring the Luster to Creative Deal Lock-ups?

By Daniel E. Wolf, David B. Feirstein, and Joshua M. Zachariah, Partners, Kirkland & Ellis, LLP | Posted on

[Editor’s note: The following post comes from Kirkland & Ellis’s recent M&A Alert by Daniel E. Wolf, David B. Feirstein, and Joshua M. Zachariah.]

The “crown jewel” lock-up, a staple of high-stakes dealmaking technology in the 1980s M&A boom, has been showing some signs of life in the contemporary deal landscape, albeit often in creative new forms. As traditionally conceived, a crown jewel lock-up is an agreement entered into between the target and buyer that gives the buyer an option to acquire key assets of the target (its “crown jewels”) separate and apart from the merger itself. In the event that the merger fails to close, including as a result of a topping bid, the original buyer retains the option to acquire those assets. By agreeing to sell some of the most valuable pieces of the target business to the initial buyer, the traditional crown jewel lock-up can serve as a significant deterrent to competing bidders and, in some circumstances, a poison pill of sorts.

Given the potentially preclusive nature of traditional crown jewel lock-ups, it is not surprising that they did not fare well when challenged in the Delaware courts in the late 1980s. As the Supreme Court opined in the seminal Revlon case, “[W]hile those lock-ups which draw bidders into a battle benefit shareholders, similar measures which end an active auction and foreclose further bidding operate to the shareholders detriment.” Building on the holding in Revlon, the court in Macmillan said that “Even if the lockup is permissible, when it involves ‘crown jewel’ assets careful board scrutiny attends the decision. When the intended effect is to end an active auction, at the very least the independent members of the board must attempt to negotiate alternative bids before granting such a significant concession.” Although crown jewel lock-ups fell out of favor following these rulings, modern and modified versions of the traditional crown jewel lock-up have been finding their way back into the dealmakers’ toolkit.

During the height of the 2008 financial crisis, we saw a crown jewel lock-up in its most traditional form in the JPMorgan rescue acquisition of Bear Stearns. Driven by “life-or-death” urgency, Bear Stearns agreed to an option for JPMorgan to buy its Manhattan headquarters for approximately $1.1 billion, including in circumstances where a topping bid emerged. In the ensuing litigation, the plaintiffs argued that the option to purchase the building constituted an “effective” termination fee because the purchase price under the option was allegedly below fair value. A New York court, applying Delaware law, rejected this argument stating that the record did not substantiate the claim that the price was below fair value. The court, mindful of the extreme circumstances, also noted that the plaintiffs’ criticism of the “effective” termination fee and lock-ups as being excessive or unprecedented was also misplaced because Delaware law does not “presume that all business circumstances are identical or that there is any naturally occurring rate of deal protection, the deficit or excess of which will be less than economically optimal.”

To read the rest of this post, click here

HUD’s New Fair Housing Rule Could Face Supreme Court Scrutiny

By Margaret Dreschel, J.D. Candidate 2015 | Posted on

The Housing and Urban Development Agency (HUD) recently issued a new “disparate impact” rule – essentially codifying the main method used to prove housing and lending discrimination for the past several decades – but the timing of this move may say more than the rule itself.  The new rule has come into effect while the Supreme Court is deciding whether or not to hear a critical housing discrimination case, Mount Holly v. Mt. Holly Gardens Citizens in Action.   If the Court grants cert, it has the potential to overturn the very substance of HUD’s new rule and, more importantly, the “disparate impact” method of fighting housing and lending discrimination in general.  Among the many stakeholders, this has considerable impact on the banking and insurance industries, which have faced an increase in lending and rate-setting discrimination lawsuits based on “disparate impact” claims.  You can read the HUD rule here, and you can read the Mount Holly petition for a writ of certiorari here.

In the case, the Mount Holly Township in New Jersey determined that a residential area known as “the Gardens” was blighted, and it moved forward with redevelopment plans for the area.  Although the Township acquired and demolished most of the houses in the area over several years, it failed to build new housing.  Residents of “the Gardens” eventually sued and won on the claim that the Township’s actions have had a disparate impact on African Americans.  On appeal before the Supreme Court, the Township now raises the question whether “disparate impact” is a cognizable claim for proving discrimination under the Fair Housing Act.

As the agency responsible for enforcing the Fair Housing Act, HUD works to sniff out illegally discriminatory housing practices based on protected characteristics (e.g., race, ethnicity, disability, etc.).  It has long interpreted the Act so that even where discriminatory motivation is missing or hard to prove, HUD can still prosecute lenders or landlords, for example, if their practices cause protected persons to suffer unjustified and disproportionate harm.  This is known as the “disparate impact” principle that is now codified into the rule.  Based on a three-part burden-shifting test, the rule often makes it easier for plaintiffs to establish a practice as discriminatory since they do not have to prove the more subjective motivation behind that practice.

HUD’s reason for promulgating the rule is simple enough on its face: the agency wants to ensure a formalized, consistent application of the “disparate impact” principle nationwide.  At the same time, HUD and the Obama administration are also likely taking proactive measures in light of Mount Holly, given that the principle may have a better chance of surviving the Court’s review if backed by a codified federal regulation.

More broadly, this decision could have significant implications for home insurers and banking institutions like Wells Fargo and Bank of America, which have been the latest targets of discriminatory lending lawsuits.  The Obama administration has relied heavily on the “disparate impact” principle to go after discriminatory mortgage lending practices, pointing to data showing higher interest rates and less favorable loan conditions provided to minority persons.  In the process, the administration has won some of the largest settlements in history worth hundreds of millions of dollars for minority communities across the country.  Banks maintain that these settlements are the undue cost of avoiding litigation rather than any real finding of discrimination, and that the inevitable result is a transferred cost to the consumer.  The American Banking Association, in particular, has expressed concern that HUD’s rule creates “unnecessary compliance risk,” which then limits credit availability and drives up the cost of borrowing in a recovering economy.

Therefore, civil rights advocates and the American Bankers Association (ABA) are well aware of the high stakes if HUD’s rule is upheld or overturned.  If the Supreme Court takes the case, the waiting period begins; otherwise, HUD and civil rights advocates may have a greater sense of closure for the present.

For further reference, please see this Wall Street Journal article and this ProPublica article.

BCLBE Russian Market Conference: Cross-Border Investment

By Amanda Berloni, L.L.M. Candidate 2013 | Posted on

Earlier this month, the Berkeley Center for Law, Business and the Economy hosted its latest conference on the “Russian Market: Legal and Business Perspectives.”  The Network extensively covered the series of speakers and panel talks, with special attention to its IP and innovation topics.  This post considers international investment in the Russian market.

Panelists Michael Sanders and Ramsey Hanna discussed the Russian investment climate and the challenges of completing cross-border transactions.  Specifically, Sanders and Ramsey analyzed the joint venture between RUSANO and Domain Associates to highlight the business culture challenges of completing cross-border investment transactions with Russian firms.  In March 2012, RUSANO, a Russian open joint stock company, and Domain Associates (“Domain”), a U.S. venture capital firm, entered into an investment agreement.  Pursuant to the agreement, the parties agreed to jointly invest in emerging life sciences technology companies, foster transfer of technology into Russia, and establish pharmaceutical manufacturing facilities in the country.  Sanders and Ramsey noted the importance of building trust and confidence between RUSANO and Domain.  That is, successfully negotiating the joint venture’s terms required developing good working relationships between the parties’ legal teams and those individuals charged with structuring their partnership.

Conducting business with firms from different markets is not without its challenges.  Russian firms employ different negotiation tactics and the negotiation process can be lengthy and detailed.  As the director of a US pharmaceutical firm wrote, “Russia is a great place to operate – you can really build a strong, profitable business here – but there are no shortcuts.”  In negotiating the RUSANO-Domain joint venture, the parties dealt with the counter-effects of corruption.  To be sure, there is tendency among Russian firms to focus on procedure and formalities.  In the face of corruption and bribery, honest Russian firms strive for transparency and can be “methodical to a fault.”  The “rigid business culture” in Russia can be contrasted with the more “nimble start-up culture” present among Silicon Valley firms.

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CFPB Announces “Ability to Repay” Rule for Mortgage Lenders

By Amanda Berloni, L.L.M. Candidate 2013 | Posted on

The Consumer Financial Protection Bureau has announced a new rule (the “Ability-to-Repay rule”) requiring mortgage lenders to ensure that potential borrowers will be able to repay their mortgages.  The CFPB is charged with amending Regulation Z, which carries out the Truth in Lending Act.  The CFPB also implements the ability-to-repay requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).  Under Dodd-Frank, creditors must make a reasonable and good faith determination that borrowers have a reasonable ability to repay the loan.

The Ability-to-Repay rule is aimed at protecting American consumers.  According to the CFPB Director, the “Ability-to-Repay rule protects borrowers from the kinds of risky lending practices that resulted in so many families losing their homes.”

Under the new rule:

  • 1. Lenders are required to obtain and verify financial information from potential borrowers,
  • 2. Lenders must evaluate and conclude that potential borrowers have sufficient assets or income to repay the loan, and
  • 3. Lenders cannot use lower, introductory “teaser” interest rates (which cause monthly payments to jump to unaffordable levels) to base their evaluation of a potential borrower’s ability to repay the loan.

In assessing whether a borrower will be able to repay their loan, lenders must generally consider the following underwriting factors:  1) current or reasonable expected income or assets, 2) current employment status, 3) the monthly payment, 4) monthly payment on any simultaneous loan, 5) the monthly payment for mortgage-related obligations, 6) current debt obligations, 7) monthly debt-to-income ratio, and 8 ) credit history.

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BCLBE Russian Market Conference: The Innovation Aspect

By Natalia Katunkina, J.D. Candidate 2014 | Posted on

In a follow up to a previous post, an interesting aspect of the “Russian Market: Legal and Business Perspectives” symposium was the panelists’ discussion of Russia’s treatment of domestic and foreign businesses—and argument that it is a large stop sign for many investors.  Consequently, the oil-focused government has for years ignored one of its chief assets—the country’s young science and technology innovators.  Educated in traditionally math-heavy state schools and inspired by the successes of Sergey Brin and Arkady Volozh, they too are ready to innovate.  This undervalued science and technology talent has attracted many Indian and Chinese investors to explore Russia, and these investments have proven to be lucrative.

The panelists agreed that Russian entrepreneurs tend to generate highly original proposals.  “Russians don’t usually pitch yet another social network idea,” observed Stephanie Marrus, Director of the Entrepreneurship Center at UCSF.  Building on her comment, Axel Tillman, CEO of RVC-USA, shared an example of how a small team of Russian engineers, within days, developed a commercially-viable way of avoiding a costly energy distribution inefficiency in the elevator industry, which many others thought permanent and inevitable.

The panelists also discussed how Russian entrepreneurs tend to have a can-do attitude and a strong confidence in their own ability to overcome obstacles to innovation.  While valuable in many respects, these tendencies, if unchecked, can result in delays and frustrations even for entrepreneurs themselves, as they attempt to accomplish unfamiliar business tasks on their own, often without consulting an expert even when one is available.  The resulting delays can be highly damaging for the outlook of a business, both in the short- and long-term future.

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Professor Gadinis Comments on the Recent DOJ Suit Against S&P

By Luke Burton, J.D. Candidate 2015 | Posted on

The Department of Justice recently brought charges of mail fraud, wire fraud, and financial institution fraud against Standard and Poor’s Rating Service, owned by parent company McGraw-Hill. It was filed in federal court in Los Angeles. (Read full complaint here).

The DOJ’s civil action against S&P calls for at least $1 billion in civil penalties, and the complaint alleges the rating agency defrauded investors out of as much as $5 billion. The fraud is claimed to have occurred as S&P purposely misled investors in an effort to increase the use and revenue of its ratings service. S&P’s press release denied any allegations that the company behaved in any manner other than “good-faith” when grading RMBSs and CDOs, and further questioned the legal merit of DOJ’s case.

The complaint states that DOJ is going to use the Financial Institutions Reform, Recovery, and Enforcement Act to extract civil penalties from S&P for misrepresenting material facts to investors in an effort to increase profits and market share for its rating business. FIRREA was enacted in 1989 in response to the Savings and Loan Crisis. The statute was little used before it was resurrected by prosecutors who realized the statute might be of particular value for pursuing fraud that occurred during the sub-prime mortgage crisis.  FIRREA is a particularly strong tool for prosecutors because it imposes large civil penalties (up to $1 million per offense), has a long statute of limitations period (10 years), and allows prosecutors to have much greater investigative tools than they would normally enjoy in a civil case (e.g. prosecutors can take testimony from individuals).

Perhaps most importantly, FIRREA only requires that prosecutors prove their case by a preponderance of the evidence. The statute could essentially give DOJ many powerful evidentiary tools and punitive remedies, most commonly seen in criminal cases, but would not require them to demonstrate their case to the onerous reasonable doubt standard.

Because DOJ lawsuit against a ratings agency is uncharted legal waters, much remains to be seen about the merits of the case. Berkeley Law Professor Stavros Gadinis notes that courts have required a high evidentiary burden in the context of fraud litigation in order to curb frivolous or unmeritorious claims. “In Tellabs v. Makor, which concerned 10b-5 litigation, the Supreme Court held that, in order to establish scienter (broadly speaking, intent to defraud or knowledge), courts must look at the evidence as a whole, and not at just excerpts hand-picked by the plaintiffs.” Professor Gadinis explained, “In the S&P’s case, this could mean that, if one looks at email correspondence as a whole, their employees have expressed enough support for their ratings to disprove the claim that these ratings were clearly part of a scheme to defraud.” However, because FIRREA has been rarely been utilized, there is little case law to aid in forecasting how a court might rule. Gadinis emphasized that the reasoning in Tellabs pertained to 10b-5 litigation, thus the extension of the Court’s reasoning to FIRREA “remains an open question.”

 

Former Senior Executives Receive Lucrative Consulting Arrangements

By Bali Kumar, J.D. Candidate 2013 | Posted on

For some senior executives at major companies, retirement does not lead to the cessation of income.  Aside from pension and/or severance benefits, some retired executives are retained as consultants.  The Wall Street Journal illustrates the variety of purposes former executives can serve as consultants, including relationship management, closing deals, and facilitating new executive transitions.

For example, Phillip E. Powell of First Cash Financial Services, Inc. is former executive who received a lucrative consulting arrangement after retirement. According to First Cash Financial Services Inc.’s most recent proxy statement, Powell performs “such services as may be requested by the Board of Directors.”  This consulting arrangement began in 2005, and the term of this arrangement extends through the end of 2016.  For his services, Powell receives $700,000 per year for an unspecified number of hours of work.  If the company terminated his contract in 2011, he would have been paid out the remaining $3.5 million on his contract.

This is a highly rewarded consulting contract.  Based on 2011 salary alone, Powell earned one of the highest salaries of any First Cash Financial Services Inc. employee in that year.  In 2011, no employee other than the President and CEO earned a higher base salary than Powell.  In terms of 2011 total compensation, Powell would be within the top five most highly compensated employees, earning more than two Named Executive Officers: General Counsel Peter Watson and Vice President of Finance Jim Motley,.

The fact that Powell’s total package places him among the ranks of the most highly compensated employees of First Cash Financial Services Inc. is noteworthy, especially considering his salary is guaranteed—there is no performance-related element to his pay package.  This means that Powell is not held accountable for his performance in the same way that executive officers are.  This clearly demonstrates that the Board of Directors of First Cash Financial Services Inc. considers Powell’s consulting services to be extremely valuable.

Powell is one of many executives who benefit from consulting contracts after stepping down from their executive role.  According to Business Insider, “semi-retirement” can allow for either an effective transition from one executive to another or potentially be a new pool of funding for severance packages.  In either case, the pay packages are lucrative.

The Week in Review: FB, BNY Mellon, and Cybersecurity

By Christopher Hammond, J.D. Candidate 2015 | Posted on

Facebook (FB) has cleared an important legal hurdle, as a S.D.N.Y. district court dismissed a lawsuit regarding its fumbled IPO last May.  The plaintiffs had argued that CEO Mark Zuckerberg and other directors should be liable for selectively disclosing negative measures of the company’s performance.  Judge Sweet disagreed.  Unsurprisingly, a Facebook representative said they were “pleased with the court’s ruling.”  For more, see CNBC.

The IRS won a major case in U.S. Tax Court earlier this week, and the ruling could cost the Bank of New York Mellon more than $800 million.  The dispute arose from Structured Trust Advantaged Repackaged Securities (STARS) – essentially manufactured tax shelters marketed by the bank.  In ruling against BNY Mellon, the Court held the STARS program was a “subterfuge for generating, monetizing and transferring the value of foreign tax credits.”  For more, see the Wall Street Journal.

In a follow-up to a previous Network post, President Obama has signed an executive order on cybersecurity.  However, the President’s order does not reach tough new regulations on private companies, falling short of last year’s proposed legislation, and does not allow for broad information sharing with government intelligence agencies as proposed by CISPA.  Congressional reaction to the executive order is yet to be determined—some commentators view the move as taking pressure off Congress to act on cybersecurity this term, but even President Obama, in his State of the Union address last night, addressed the need for a comprehensive law.  For more, see CNET and BBC.